A Week After Madeira-Gate, Moody's Downgrades Them to B3

Last Friday, Blooomberg reported the mysterious appearance of unreported debts by the island of Madeira. A week later, Moody's steps up to the plate and slaps a two-notch downgrade on the Autonomous Region due to (among other things) "grave irregularities" in the region's budget reporting. It is little wonder that investors are reducing exposure to government debt throughout Europe as these little anomalies keep popping up among the weaker oh-so-desperate-to-be-among-the-in-crowd sovereigns.

Full Statement: Moody's downgrades the Autonomous Region of Madeira to B3 from B1 (Portugal)

Madrid, September 23, 2011 -- Moody's Investors Service has today downgraded the long-term issuer rating of the region of Madeira to B3 from B1 following concerns over the region's poor governance and management as well as its weak budget execution. The rating action concludes a review for possible downgrade commenced on 7 July. The rating remains on review for further possible downgrade.

RATINGS RATIONALE

Today's downgrade reflects Moody's concerns over the region's poor governance and management as well as its weak budget execution, which were heightened by the Ministry of Finance's publication of a press release revealing "grave irregularities" in the region's budget reporting. Madeira has failed to report around EUR1.2 billion (approximately 130% of the region's annual revenue) in commercial liabilities over the last few years. This adds to the EUR568 million (around 65% of the region's revenue) to be recorded in the regional deficit and debt for H1 2011, which was already announced in early September by the Portuguese Finance Minister.

Given the magnitude of the amounts disclosed, we believe that Madeira will continue experiencing budget pressure for some time, as absorbing those liabilities into its budgets is likely to take several years. When including these unfunded liabilities in the region's debt metrics -- as these obligations will most likely have to be funded through the recourse to financial debt -- Madeira's net direct and indirect debt stock would soar to more than five times its revenue by the end of 2011. This represents a substantial increase from the already high debt ratio of roughly 380% of revenue recorded at the end of 2009 driven mainly by the significant debt of regional companies. Moreover, Moody's notes that the region's high funding requirements will prove difficult to fund via bonds or even long-term loans at an affordable cost, should the current market sentiment towards Portuguese issuers be further protracted, therefore rendering essential the central government's support in resolving this matter.

FACTORS TO BE CONSIDERED IN THE REVIEW

Moody's understands that Madeira has solicited the collaboration of the central government to develop a restructuring plan. The central government is currently scrutinising the region's finances and over the next few weeks, a clearer picture of the regional accounts and that of its related companies will emerge. Thereafter, the central government is expected to propose concrete measures to redress the financial position of the region, including a timetable for it to repay its newly disclosed commercial obligations.

Moody's review will focus on the content of this package. We will examine the measures to be applied in order to rein in costs and bolster revenue (such as the suspension of investment programmes, scope and scale of potential tax hikes) in order to assess the implementation risks in the context of the region's track record of poor fiscal discipline. The timeframe of this rebalancing plan and the involvement of the central government in its realisation will also be critical to our analysis.